Deleveraging

Dave SchulerNovember 27, 2012

The question that occurred to me in reading Bill McBride’s most recent post in which he noted a report from the NY Fed that indicated that consumer indebtedness had declined .7% from the second quarter of 2012 to the third quarter of 2012 was is that good news or bad news? You be the judge.

I did a little back-of-the-envelope calculation and found that, if consumer indebtedness declines at that rate until it reaches its level in the first quarter of 2003, that would take 57 quarters, just shy of 15 years. A quick check of the history suggests that we have never experienced a decline of that length. Indeed, the history of the post-World War II United States, the period of our greatest prosperity, is one of ever-greater expansion of consumer indebtedness.

However, if what we’re experiencing is a balance sheet recession, household indebtedness declines at the rate that it did in the report, and the magic target number is the level of indebtedness we had in 2003, it looks to me as though we have a problem. The problem is that much bigger if the magic number is the level of, say, 1993. Or 1983.

The primary component of “de-levereging” here is in real estate. That could easily reflect continuing problems in the housing market. It could mean fewer first time buyers, either because they have lower demand for home ownership or cannot get credit. Meanwhile, the existing homeowners are not moving as much as they used to and some of them are taking advantage of re-financing.

I’m surprised total credit card debt is almost a tenth of total auto debt. I’m not sure why; I would think credit card debt would be higher.

To be clear here. First time buyers not leaping into the housing market as early in life might be good for them. Its not necessarily good for the housing market, which has grown to depend on churning of ownership. I don’t know that house prices have dropped sufficiently yet in many parts of the country.

given tight lending standards, overall debt is likely shifting to higher income households which would positively affect the debt service/income ratio

The dirty little secret of the household debt issue is that by far the greatest amount of household debt has been held by people in the top quintile of income earners for years. That’s actually pretty easy to understand. People in the bottom quintile don’t buy or finance million dollar houses.

And I don’t think that my analysis is pessimistic, just sobering. I’m merely pointing out the necessary concommitants of the assertion that we’re in a balance sheet recession and the rate at which deleveraging is occurring. We’d better hope that it wasn’t a balance sheet recession or else we need to be deleveraging much, much faster than we are. I don’t see any way that can happen without federal prodding.

Federal prodding? Fiscal policy was possible in the 30s since they entered with low levels of public debt. Forcing write downs of mortgage debt? I have no idea if the banks can take this yet. Not sure if it is politically possible. What else do you have in mind? (Debt had been dropping faster until that quarter.)

I guess export growth remains possible, but the EU is going into recession, and China slowing down. Growth is how we have gotten out of this kind of problem in the past, but I dont see where that is coming from. Suppose Obam is impeached and we put a GOP demigod in office. All of those businessmen feel appreciated and start investing like crazy. Where do they get that money, and do we really need them debt financing another expansion just like they have all of the others since 1980? Where does the consumer get the money to buy? I just dont think there is a quick and easy way out of simultaneously running up private and public debt, especially private.

And even at that rate it was intolerably slow. A dozen years is a good part of a career, a working life.

If the banks can’t stand it, they should fail. And we should deal them the way that Sweden did when they had their banking crisis.

An additional factor that needs to be mentioned: deleveraging is a perfect use for Ben Wolf’s perennial suggestion—just spending the money into existence. Mark to market and then buy up the paper with other paper.

There is no need to force mortgages to be written down. The financial institutions have capital requirements, and they must be solvent. Somebody thought it was a good idea to lend money to people who could not afford the payment, and this loan was secured by an overpriced house. It was not a good idea, and that somebody needs to learn that.

I think one aspect of the problem is quality not quantity. A mortgage on a house that can be sold with little or no loss is different from a mortgage on an underwater house. Also, a lot of people were using their house as an ATM.